Spain Has EU’s Largest Deficit, Undermining Rajoy Pickup

A pedestrian passes the bricked up windows of a closed store in Madrid. The Spanish economy is suffering from a persisting credit drought. Photographer: Angel Navarrete/Bloomberg

April 22 (Bloomberg) -- Spain’s budget deficit was the
largest in the European Union last year, underlining the
challenge faced by Prime Minister Mariano Rajoy as he prepares a
new plan to foster an economic recovery.

Eurostat, the EU’s statistics agency in Luxembourg, today
reported that Spain’s 2012 deficit widened to 10.6 percent of
gross domestic product, swollen by the cost of bailing out its
banking system. That’s up from 9.4 percent in 2011 and is worse
than Greece’s 2012 budget gap of 10 percent. A limit of 3
percent of GDP is imposed by the EU on all members.

Rajoy pledged last week to unveil measures on April 26 to
make the euro region’s fourth-largest economy more flexible and
competitive. That announcement will end a week of reports
ranging from a first-quarter GDP estimate to data showing
whether unemployment has reached another record.

European stocks today rebounded from the biggest weekly
drop in five months as Italy elected a president and the Group
of 20 nations offered no opposition to Japan’s stimulus
policies. The Stoxx Europe 600 Index was up 0.9 percent at 11:48
a.m. in London. The euro was down 0.1 percent at $1.3041.

Rajoy is bidding for more time from EU peers to reorder
public finances as he aims to end a six-year economic crisis,
aided by the European Central Bank’s pledge to do whatever it
takes to preserve the euro. International Monetary Fund Managing
Director Christine Lagarde said last week that the Spanish
government needs more time to reduce its deficit.

Structural Improvement

“Spain needs another two to three quarters to fully
reassure investors,” said Gilles Moec, co-chief European
economist at Deutsche Bank AG in London. “Beyond the ECB’s
support, it must prove the economy’s improvement is structural
and that the bank recapitalization is sufficient to deal with
the increase in non-performing loans.”

The country’s shortfall grew while the euro area’s combined
deficit narrowed to 3.7 percent of GDP from 4.2 percent a year
earlier. Germany had a budget surplus last year, while Italy was
within the EU limit at 3 percent and France and Ireland reduced
their gaps to 4.8 percent and 7.6 percent respectively. Greece’s
deficit widened from 9.5 percent in 2011.

Spain’s overall debt load surged to 84.2 percent of GDP
from 69.3 percent. While that’s still below the euro region’s
average of 90.6 percent, the European Commission forecasts it
will breach the average this year.

‘Cheap’ Investment

The Spanish Treasury last week sold 10-year bonds at the
lowest yield since 2010, completing 43 percent of mid- and long-term funding needs for 2013. Still, investors demand about 3.4
percentage points more than to lend to Germany for the same
maturity.

“Spain has become cheap for investors, as the probability
of a European aid request is low,” said Jose Antonio Herce, a
partner at Madrid-based consultancy firm Analistas Financieros
Internacionales. “There is still a lot to do but over the past
year the government has succeeded in stabilizing the banking
system and reducing the deficit.”

Excluding aid to banks, the 2012 budget deficit was 7
percent, according to the Budget Ministry.

Along with economic measures, Spain’s cabinet will on April
26 formally sign off on mid-term budget plans even without
receiving an update from the EU on its 2013 deficit limit for
the country, currently at 4.5 percent of GDP.

Shrinking Economy

That will follow the release of labor data on April 25
showing that unemployment rose to a record 26.5 percent in the
first quarter, according to the median of eight estimates in a
Bloomberg News survey of economists.

Rajoy has signaled that the economy will probably shrink
this year by more than the 0.5 percent he previously forecast.

The Bank of Spain, which predicts a 1.5 percent contraction
in 2013, will this week publish its GDP estimate for the first
three months of the year. Economists forecast a drop of 0.5
percent and the seventh quarter of recession. The economy shrank
0.8 percent in the final three months of last year, the most
since 2009.

Inditex SA, the world’s biggest clothing retailer, missed
analysts’ profit estimates in the last quarter of its fiscal
year as the toughest austerity in 30 years of democracy
undermined its home market.

Credit Drought

The Spanish economy is suffering from a persisting credit
drought. Mortgage data to be released on April 24 may confirm
that banks continued to restrict credit in February after bad
loans amounted to 10.4 percent of total lending that month.
Banks’ asset quality is vulnerable as the weakness of euro-area
economies including Spain affects as much as 20 percent of non-bank corporate debt, the IMF last week said in a report.

“Indicators are still pointing to the continuation of a
pretty deep recession,” said Jonathan Loynes, an economist at
Capital Economics Ltd. in London. “If we see a re-escalation of
the euro-zone crisis -- whether due to the Cyprus episode or
Italy’s political deadlock -- that could push borrowing costs up
across the region, and Spain would clearly be affected.”

Rajoy will seek to convince investors that such a scenario
can be avoided as he continues to overhaul the economy after
claiming measures to overhaul labor rules improved
competitiveness and helped drive exports to a record.

His plans now include tax changes to help entrepreneurs, a
reorganization of the public administration to make the pensions
system sustainable and regulation changes for energy,
telecommunications and transportation.

“Spain doesn’t look altogether different from the U.K. or
France,” said Robert Wood, an economist at Berenberg Bank in
London. “Of course with debt heading up towards 100 percent of
GDP, big deficits and the economy contracting, bond yields are
bound to be higher than in Germany, but rising up to 7 percent
wasn’t warranted.”